Pharmaceutical manufacturers have responded to the new regulatory and competitive forces by restructuring their operations. I focus here mainly on changes involving companies serving the United States market, with which I am most familiar.

As the choice of drugs has become increasingly centralized within hospital and HMO formulary committees, the drug makers' traditional approach to selling - sending salespersons (called «detail men») out to meet the more than half million individual physicians, provide promotional literature and free samples, and explain the merits of company products - has lost much of its effectiveness. Drug companies have «downsized» by shedding redundant sales personnel and also, to maintain profitability despite rising pressure on prices, many other administrative staff members (IRVING, 1991, pp. 18-28; IRVING, 1992, p. 42).

In recent years the companies have also attempted to adapt to new challenges by undertaking a flurry of mergers. Table 1 summarizes the principal mergers consummated or proposed between 1989 and 1995 by pharmaceutical companies operating within the United States. The mergers are divided into two rough categories, «horizontal» and «vertical». Acquisitions of companies operating in fields with no evident relationship to the pharmaceutical Industry are excluded.

The horizontal mergers appear to be motivated in large part by the desire to reduce overhead costs - e.g., for sales and central office personnel - and by the belief that economies of scale and risk-spreading might be achieved in new drug discovery and development programs. With the cost of a successful new chemical entity research and development averaging upwards of $ 100 million, small companies face high risks of failing to find replacements for products facing competitive obsolescence, and even the larger companies have seen advantages in risk-pooling.

TABLE 1. - Significant mergers and acquisitions in the United States by pharmaceutical companies

n/d: Not disclosed.
* Combined value of merged entity.

Moreover, larger companies appear to enjoy significant advantages in coping with the stringent regulatory regime that has evolved since the Kefauver-Harris Act of 1962. The first convincing evidence of such advantages was adduced by L.G. Thomas, who found that between 1960 and 1980, large U.S. companies maintained the productivity of their R&D in generating new products, taking the experience of less heavily regulated British firms as a benchmark (THOMAS, 1990, pp. 497-517). However, for smaller U.S. drug firms, relative R&D productivity fell dramatically. Further insights paralleling those of Professor Thomas come from more recent research by DiMasi and colleagues (DIMASI, GRABOWSKI and VERNON, 1995). From an analysis of twelve U.S.-owned company product portfolios, they report that the average R&D cost per approved new product tested between 1970 and 1982 was about 14 per cent lower in the largest firms than in the small and medium-sized companies. Large companies realized their most prominent savings in pre-clinical work. But more importantly, DiMasi et al. found that new product sales in the first three years of marketing were nearly twice as high in the largest companies than in medium-size companies and 6.7 times the average for the smallest firms. The authors took care to classify companies by their size at the start of the sample period, before sales could be affected by the superior sales of the newly introduced products. The precise source of the largest companies' advantage remains unclear. It could come from larger firms' conscious choice to allocate R&D resources mainly to disproportionately ambitious challenges with large potential payoffs contingent upon success, to conditions within R&D laboratories that make it possible to discover more important new products on average, to greater effectiveness in marketing the products that emerge from testing, or some combination of the three. Whatever the mixture of explanations, if the observed R&D productivity differences persist, smaller pharmaceutical companies are likely to be relegated to increasingly marginal positions in the market. To avoid this fate, they may prefer acquisition by a larger rival.

Mergers and (more commonly) joint ventures also combine the skills of old-line pharmaceutical houses with the quite different aptitudes of newer biotechnology firms. Creating new drugs through gene splicing, cloning, and the like requires scientists trained in research strategies and techniques less familiar to the organic chemists populating traditional drug makers' laboratories. Making common cause permits the (typically small) biotech firms to obtain R&D capital on favourable terms and to take advantage of pharmaceutical companies' expertise in bringing new chemical entities through the elaborate trials required by the Food and Drug Administration and to market approved new products quickly.

The recent flurry of mergers classified as vertical in Table 1 has a quite different rationale. Pharmaceutical benefit management companies (PBMs) have brought new forms of price competition to the Industry. They typically provide either or both of two services. For the large companies or groups that enlist their services, they maintain mail-order pharmacies to dispense maintenance drugs at low transaction costs, and they execute the vast amount of paperwork required to reimburse retail pharmacies dispensing drugs to individual patrons covered by client company insurance plans. In both roles, they can deny favourable listings on their formularies to drug manufacturers who fail to offer substantial price concessions. By acquiring PBMs, drug manufacturers Merck, SmithKline Beecham, and Lilly hope to ensure that their own products retain prime positions on those formularies and hence to enhance their sales. In effect, they enjoy a second-mover advantage, being able to match any price concession offered by rivals to their captive PBM. In addition, the drug makers believed that they would enrich their channels of communication with prescribing physicians and retail pharmacists, strengthening their direct selling efforts (to replace in part the efforts of detail men) and accumulating information on drug-taking patterns to guide future R&D efforts (NICHOLS, 1994, pp. 1110-1112). The companies acquiring PBMs may be correct in these expectations. However, if they gain an appreciable advantage, other drug manufacturers are likely to acquire their own captive PBMs or, if the supply dries up, to enter the PBM business de novo. Then the strategic advantages of controlling a PBM will be neutralized. And if many PBM-owning manufacturers favour their own products, firms may compete less vigorously for preference on their rivals' formularies. The result may be a reduction of the price competition independent PBMs stimulated.